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natural resources

Imagine a product that has these uses1:
• Vital part of every home and building.
• Goes into every vehicle; hybrids and electrics use up to four times more.2
• Needed for manufacture, installation and use of solar panels and wind turbines.
• Key requirement in making batteries.

One might imagine that demand for this product will rise in coming years, as technology changes our power grid and transportation, and the world continues to modernize.

Now consider the supply side. It takes billions of dollars and four years or more to create a new production facility. The industry that produces it went through a depression as prices for the product got cut in half from 2011 to 20163. Revenues disappeared, losses mounted, spending got slashed. New projects were cancelled.

Rising demand, constricted supply: we know how this works. Prices will rise, revenues and earnings for producers will go up, stock prices may follow. No guarantees, of course, and the timing is always uncertain.

The product is COPPER. There is no replacement for it. The question we face as investors is, can we get involved on a favorable basis?

We know companies that produce a lot of copper, along with other resources. Their stocks are traded on the New York Stock Exchange. The valuation on their shares seems compelling. A dollar of profit in one trades for a third less than that of the average stock; the other one carries a two-thirds discount. One is trading at one-third of its all-time peak a few years back, the other is discounted even more.

Both stocks have been about twice as volatile as the average stock. (This is measured by a statistic called ‘beta.’) We don’t care. Downside volatility is wonderful if you are trying to buy bargains. But owners should be prepared for the roller-coaster.

Clients, we are telling you this story for a reason. When you hear that ‘the market is too high’ or things are at some unsustainable peak, remember that at 228 Main, we are pounding the table and jumping up and down about the bargains we are finding. If you would like to discuss this or anything else at greater length, please email us or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

Investing involves risk, including possible loss of principal.

The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.

We’ve written before about our positions in natural resource sector companies. They were key to both our pain in 2015 and our pleasure in 2016.

Noted investor Jeremy Grantham of Grantham, Mayo & van Otterloo (GMO) recently published additional insights on this topic in a white paper. Three of his nine key points are worthy of special mention:

1. “Resource equities have not only protected against inflation historically, but have actually significantly increased purchasing power in most inflationary periods.” Regular readers know we believe that prospects for increasing inflation are under-appreciated in today’s markets. Although we have no guarantees that we are correct in this view, and past performance is no guarantee of future results, we may be very well-positioned for a rise in inflation.

2. “We believe the prices of many commodities will rise in the decades to come due to growing demand and the finite supply of cheap resources.” Low prices have curtailed future supplies; we know how this works.

3. “Despite all of this, investors generally don’t have much exposure to resource equities.” As eclectic contrarians, we are used to marching to a different drummer. This is certainly the case in 2016 with regard to our exposures in this sector. The unstated premise is that when the crowd decides to gain exposure, a lot of money may shift into the sector. Again, no guarantees.

We are watching economic, business and market trends closely to see how this all comes out. We enjoyed the analysis by Jeremy Grantham, even as we guard against the fallacy of believing he is a genius because he agrees with us. As always, please call or email if you would like to discuss your position.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.